The government is likely to modify the draft direct tax code to retain tax shelters and principal repayments for home loans to make the new code more attractive for the average Indian, said a Finance Ministry official.

According to the proposed direct taxes code there would be no tax incentives for loan-funded house purchases that are for personal use. The code is expected to become operational from April 2011.

Presently, taxpayers are allowed to deduct interest up to 1.5 lakh every year from their incomes. Besides this, the repayment of principal amount subject to a maximum of Rs. 1 lakh is also exempted under section 80C.

The draft code has proposed to increase the maximum limit under section 80C from 1lakh to 3 lakh, but the list of eligible expenditure/savings does not include principal repayment. The code also restricts interest deductions to houses that have been financed for renting out and where such income is included in the income of the assessee.

At present, if a home buyer in the highest 30% tax slab were to avail the maximum tax exemption available on home loans then government loses over Rs 77,000 in tax.

The proposed discontinuation of the tax benefits has faced widespread criticism. The Finance Minister, Pranab Mukherjee has indicated his willingness to review the debatable issue. He has had talks with senior officials of the apex direct tax body, Central Board of Direct Taxes (CBDT), on the proposed alterations to make them widely accepted.

The UPA-led government has lined up reforms of both direct and indirect tax structures that have a plethora of exemptions. It is considering implementing a comprehensive goods and services tax on the indirect taxes side.

The tax reforms are aimed at increasing compliance and expanding the tax base by discontinuing certain exemptions. The government hopes to redraft the new code quickly in order to present it in the next parliament session.